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The following article discusses session three in the IR Global Virtual Series on 'Redistributing Share Capital – Considerations for family-owned enterprises'
U.S – Texas – DL In the US, it has become normal to
work using limited liability company agreements for private transactions and
not public companies. But even in private transactions among public companies,
the use of limited liability company agreements and complex partnership
agreements is happening.
In the case of structuring wealth for families or bringing
in employees, it's much more common to use shareholder agreements, or often no
agreements at all.
I would say that most of our transactions use limited
liability company agreements that are highly negotiated with details on the
rights that are given to the minority investor. This includes control rights,
security rights, methods of securing the investment and possibly even ways to
increase their share if the company doesn't perform to the levels negotiated.
U.S – California – JF Do you see situations where
minority interests are protected by the preferred status of their ownership
interest, where any dividends or any distributions get paid to them first
according to certain ratios?
U.S – Texas – DL With private equity investments,
there's always a waterfall distribution method of drafting the partnership
agreement.
As a tax lawyer the most material difference between a
private equity limited liability company agreement and a non-private equity
limited liability company agreement is the method of distributions and
allocations of profits.
Private equity funds tend to draft all of their limited
liability company allocation provisions on what is called the target method of
distributions. The agreement drafts specifically how the cash is distributed,
ensuring that the private equity fund has a certain return coming back to their
investors. It’s based on cash and then the profits and losses are left to the
accountants to figure out allocation. The private equity funds don't care,
since all they're looking for is cash.
In a normal transaction between two businesses, the profits
and losses section would be focused on what your share of profits would be, or
what your share of losses would be and then distributions would always follow
based on the capital account accounting.
U.S – California – SG I cannot resist the temptation
to add that, whether it's a family situation or non-payment situation, cash
flow is always important. Clients are always concerned about that.
In the family situations, we actually end up using LLCs
quite a lot to establish different kinds of partnerships. This is especially
true for assets like real property.
The entity structure and how we're going to govern
businesses and assets from one generation to another is a big part of what we
do as professional advisors. A big part of my practice in those transfers are
multi-generational trusts, which probably would not be used outside of
families.
I think the equivalent in Germany is a foundation. If you
say foundation in the US, you're thinking of something that has a charitable
requirement, but I think in Germany the foundation is a private family
arrangement similar to a trust. We use all kinds of trusts to accomplish our
goals as professional advisors.
We translate these structures in an intelligible way for our
clients. It’s very common for us to use diagrams and charts to show the clients
what the legal documents are going to do. Our family clients love seeing the
diagrams showing how things are going to flow. It aids their understanding
tremendously.
Germany – MS Some very rich families in Germany have
a family foundation and this will hold 100 per cent of the operating business
of the companies.
We work with a large company, where all the profits from
operations go into a foundation. The foundation then aims to invest all the
money back into the company. This secures the future of the company because the
profits will not go out of the family.
The family members themselves only have salary agreements
and they get a salary from the foundation for their services. You do not have
minority shareholder problems, because in this foundation everyone is a member,
rather than a shareholder with profit interests.
U.S – Texas – DL This is actually very interesting
and something we would never see in my practice.
We're currently representing an international religious
organisation doing some restructuring, which has caused me to look at something
else that I had really never looked at before. That is the use of limited
liability companies for non-profit 501 C 3 organisations.
Delaware and two other states have specifically authorised
the use of limited liability company agreements for non-profits, and then
another series of 20 or so states have permitted it.
The reason I raised that is significant, because the limited
liability company is used so much due to its ease of preventing piercing the
corporate veil.
State laws are very good at saying that the limited
liability company does not have to follow all of the procedures for giving
notices to shareholders and doing all the things you have to do in the
corporate context. As a result, the limited liability company is an easy form
to operate with and still maintain a limited liability for the members. In a
non-profit organisation structure, the parent company with a large valuable
church building as an asset, can operate its for-profit activities in a
separate limited liability company agreement. If an accident occurs that would
give rise to liability, this insulates the non-profit parent from that
activity.
U.S – California – JF I'm working on one right now,
where we have European owners and Californian owners of a business. They own
the business equally and there's a conflict over the direction of the company.
We're working on a resolution to resolve the future of the
company. My client is the Californian entity and only the California entity. We
have to always be very careful about who we represent and we can't act in the
middle between different parties unless we are formally designated as a
mediator. It’s certainly the kind of thing that we get involved in on
non-family business transactions as well, where we resolve disputes among
owners by advising the parties.
One thing I want to add, is something interesting in
California. It's called judicial reference for the solution of disputes.
There are problems with arbitration and there are problems
with going to traditional courts to litigate. Judicial reference is a cross
between the two, using a retired judge who works privately to resolve a
dispute, almost like an arbitrator, but in accordance with all of the
applicable laws of California.
The parties hire the judge and direct the judge in terms of
the process, so it can be done privately and quickly. It follows the law, unlike
arbitration which does not necessarily follow the law, and is subject to
appeal. You get a ruling that you can take up on appeal if need be and it
creates a very interesting statutory alternative in California.
U.S – Texas – DL We have judges and former judges
that permeate our arbitration list, but the only way in Texas to have it
subject to appeal, is if the arbitration clause specifically provides that the
decision can be appealed if it didn't follow the law.
US – California – JF In California, it's all set up
by statute, which we sometimes call our ‘rent a judge’ program.
France – BP As advisors, we always discuss with our
clients the extent of the power they are willing to grant to new investors to
avoid dispute on this loss of power.
I have seen disputes happen with a family-owned company,
where one member of the family who runs the company, was not accustomed to
discuss with foreigners the strategy of the company. With new investors, you
will have to get accustomed to this, so the only question is how it will happen
and to what extent.
What decisions will require the approval of the new
shareholders is one specific point, while what kind of information will need to
be provided is another.
It is also important to determine if the new shareholders
are here just for a limited period of time or if they're here to stay. Some new
shareholders have invested with no intention of selling the shares, but the
situation is quite different when the new shareholders have decided they will
sell, for instance, within five or seven years.
It is necessary during the investment process, to not only
think about how the first investment is made, but also how the new shareholders
can resell their shares within this period of time. In France, one solution is
often an agreement between new and family shareholders, providing that if no
solution is found for the sale of the new shareholders’ shares, the family has
to sell the whole company.
This means that if you do not have a solution within five or
seven years, the family company will no longer be a family company.
It is our duty as lawyers to explain to all the members of
the family, the content and the impact of the new agreement, especially if it
happens that there are only one or two key members of the family who negotiate
this agreement with new shareholders while the other members of the family, do
not participate in the negotiation.
We do not only discuss legal aspects, but also the details
of the strategy of the company and also the needs of the members of the family.
This includes what their plans are for the next few years.
For instance, if it is a private fund which invests in a
French company, then they may not want distribution of dividends. All the
members of the family would have to accept that, for four, five or six years,
there will be no distribution of dividends. This has to be explained to them,
otherwise a dispute may happen.
UAE – TP Typically, a shareholder agreement is the
first thing to put in place. The key things to take into account are how to
secure the distribution of the profit, plus proper governance structure.
If these aspects are properly taken care of in the
shareholder agreement, minor disputes among partners are unlikely and, in any
case, far more manageable.
To this end, we typically use arbitration clauses, or the
court of the Dubai International Financial Centre, because it is a system which
is more like English law and a perfect forum especially for investors coming
from abroad.
Finland – TK Shareholder agreements are always
relevant, as are articles/bylaws of the company. In that sense, it's possible
to have a redemption condition in articles or bylaws that can be used in the
same way as share classes, for instance voting rights.
Brazil – LJ It is important to work with the
shareholders and the company to define a clear strategy and vision and a clear
corporate governance with functions. Putting in place independent managers,
that act apart from shareholders, is also a crucial part of the corporate
governance.
Mexico – JC Negotiating an offering of share capital,
will normally be formalised first by amending the company’s bylaws. Depending
on the kind of transaction, the parties may also execute a joint venture
agreement or a shareholders’ agreement. For matters involving family, they will
execute a shareholders’ agreement and afterwards will execute family protocol
that has been previously designated by a professional in the area.
Poland – RL The terms and conditions under which a
new investor joins a family-owned enterprise are commonly subject to regulation
of the shareholders’ agreement, in the case of a private company, and a
supplemental partnership agreement in the case of a limited partnership. These
agreements must define the scope of rights and obligations of a new investor.
Additionally, the following clauses ensure a smooth
realignment and maintenance of control over the enterprise by family members.
The exact identification of the purpose of investment, plus
ways of providing financing by a new investor (e.g. through increase of the
share capital along with providing share premium.)
Clauses around the attribution of shares to the new
investor, the future distribution of profit/dividends between family members and
the new investor are worthwhile, as are buyout clauses of the shares of the
investor by family members after execution of investment through a drag along
clause and a clause relating to the new composition of management
board/supervisory board favouring family members.
England – AC There are a number of ways that
professional advisors can smooth the process to ensure that a redistribution
happens efficiently and achieves its goals. These include project managing the
process, by prompting the parties to discuss difficult subjects at the outset
(for example, what happens if there is a dispute). We can also help to
implement appropriate mechanisms or safeguards, by ensuring that the rights and
obligations of the parties are clearly documented, with the aim of reducing the
scope for disputes in the future.
The rules in accordance with which the company must be run
are set out in its Articles of Association. Shareholders will often want to
ensure that agreements between themselves and minorities remain between the
parties. It is therefore essential that the shareholders consider putting in
place a Shareholders’ Agreement.
Often when negotiating a Shareholders’ Agreement, a minority
shareholder who has invested significant sums in the business will want to ensure
that their investment is suitably protected. This is particularly key if they
will not be appointed as a director, and therefore will not be involved in the
day-to-day decision making of the company. As previously discussed, the family
will want to ensure that it retains adequate control of the company. One method
is to set out in the Shareholders’ Agreement, a list of matters which are
fundamental and require key shareholder consents – these are often referred to
as ‘reserved matters’.
If the shares have been offered to employees as part of an
employee share scheme, then the documents governing the scheme should be
drafted by a solicitor to make sure that they comply with the various rules and
legislation. It is usual that these employee shares will be a different class,
and will not have voting rights. The aim is to provide a form of financial
compensation, without giving them rights in relation to running the company.
The rules need to be drafted to ensure that this is the case.
If there is a dispute between two shareholders, then it is
often recommended the parties consider mediation, however there is no legal
requirement to follow this path.
CONTRIBUTORS
John R. Colter-Carswell (JC) Colter Carswell &
Asociados, S.C. – Mexico www.irglobal.com/advisor/john-r-colter-carswell
Lavinia Junqueira (LJ) Tudisco, Rodrigues & Junqueira –
Brazil www.irglobal.com/advisor/lavinia-junqueira
Markus Steinmetz (MS) Endemann Schmidt – Germany www.irglobal.com/advisor/markus-steinmetz
Alex Canham (AC) Herrington Carmichael – England www.irglobal.com/advisor/alex-canham
Bruno Pichard (BP) Pichard & Associés – France www.irglobal.com/advisor/bruno-pichard
John Friedemann (JF) Friedemann Goldberg LLP – U.S –
California www.irglobal.com/advisor/john-friedemann
Steven M. Goldberg (SG) Friedemann Goldberg LLP – U.S –
California www.frigolaw.com/steven-m-goldberg
Tuomo Kauttu (TK) Aliant – Finland – Finland www.irglobal.com/advisor/tuomo-kauttu
Thomas Paoletti (TP) Paoletti Legal Consultant – UAE www.irglobal.com/advisor/thomas-paoletti
Donald R. Looper (DL) Looper Goodwine P.C. – U.S – Texas www.irglobal.com/advisor/donald-r-looper
Robert Lewandowski (RL) DLP Dr Lewandowski & Partners. –
Poland www.irglobal.com/advisor/robert-lewandowski